Profiting From eBay Covered Calls

| About: eBay Inc. (EBAY)

eBay (NASDAQ:EBAY) stock is currently selling for only 15 times forward estimated earnings, which is very cheap considering the stability of earnings and consistently high return on equity. The company reports earnings on July 18th.

Given the company's track record of beating earnings estimates each quarter by a few pennies, we can assume that earnings estimates are sound indicators of the company's future results (plus a few pennies). Thus, buying a few shares at this price point, doesn't seem like a bad idea.

Trading Covered Calls

The July 21st strike price of $41 presents an opportunity receive as much as a 55% annualized return from selling in-the-money covered calls. This is an excellent opportunity for a short-term gain and would be best utilized in a tax-free account, as part of a diversified strategy.

In-The-Money Calls

In-the-money calls are call options with underlying strike prices below the current market price. The buyer of an in-the-money call is locking in their purchase price at that call strike price. If the market price of the stock drops below the strike price before expiration, the call will expire unexercised. Selling in-the-money covered calls is a great option when you don't think the stock price is going to rise, or fall precipitously, and you want to liquidate a position.

Currently, the July 21, 2012 $41 strike price call options have a bid of $1.33. If you buy the stock at $41.20 and sell the $41.00 calls against those shares, then you could potentially lock in a theoretical selling price of $42.33 on shares that are currently trading at $41.20. If the price of the stock drops below $41, then you keep your shares and the call option premium of $1.33. The break-even price on the trade is $39.87. If the price of the stock stays above $41, then you lock in a 2.74% profit over about 18 days. This is the 55% annualized return, I wrote about above.

Similarly, the August 18, 2012 $41 strike price has an even richer options premium of $1.96. Selling covered calls on your shares with this strike price could potentially bring you a 4.27% profit in a little more than a month and a half. Again, if shares trade below $41, you get to keep your shares and the options premium. Your break-even price on the trade is $39.24, about 4.76% below the current price.

A Greater Short-term Profit

If you are targeting a sales price of $43 for your eBay shares, consider the $43 strike price August 18, 2012 calls. Sell the $43 call for a bid price of $1.03. If shares trade below $43, you'll keep the $1.03 in call option premium, netting a 2.5% return on the money invested, over about 48 days. If shares trade over $43, you'll sell your shares and collect a 6.87% profit. The break-even price on the trade is $40.17.

Covered calls are an excellent trading strategy whether you want to sell, or hold. They also give you a price point to exit your investment position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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